Gas pricing and rule of law

The government has unveiled a major economic stimulus package. It has also intervened in oil and gas pricing. It is the latter that makes a more interesting story. The prices of petrol and diesel were reduced by Rs5 and Rs2 per litre, respectively, and the government also announced the price at which the Krishna-Godavari (KG) basin natural gas will be sold.

Till the middle of the year, the state-owned oil marketing companies, faced with very high prices of crude, were suffering losses and had to turn to the government for subsidies through oil bonds. Their break-even is close to $60 per barrel of crude, and now that the prices have fallen below that, they have been able to recoup some of the losses.

The decision to reduce consumer prices of products is a balanced one—the prices of LPG and kerosene, which are still subsidized, have not been reduced, and the prices of petrol and diesel have been reduced moderately, which will still allow the companies to make some margins. This is important, as the government needs to reduce subsidies and to create fiscal space for intervention in the economy by reducing off-budget liabilities to the extent possible. It is only to be hoped that there will be no further populist reduction, allowing companies to improve their balance sheets.

A curious announcement on Friday has been the one made about the pricing of natural gas from the KG basin, and the priority now assigned for supply to the Ratnagiri power plant. The production sharing contracts under the New Exploration Licensing Policy (Nelp) provide the contractor the freedom to sell gas and he should endeavour to sell it at an arm’s-length price. In this case, the contractor had bid for supply to NTPC at a price of $2.34 per million British thermal unit (mBtu), but had not entered into a contract—a matter that is under dispute in courts. There was also an agreement between Reliance Industries Ltd (RIL) and Reliance Natural Resources Ltd (RNRL)—at that time under the same management—to supply to the latter at the same price for a power generating facility—again a matter that is in dispute in the courts. Not commenting on the merits of the claims, it is the stand of the government over time that has been curious.

Some five years after the award of the Nelp block to the contractor and the signing of the production sharing contract, the government decided to intervene in both the allocation of the gas as well as the pricing of gas. The group of ministers (GoM) constituted for the purpose decided in 2007 that for the purpose of valuation of the government’s share of the profits, the price would be reckoned at $4.20 per mBtu. The minutes indicate that this is the floor, and any higher realization will entail the government to a higher share of profits. Importantly, the GoM decided these would be without prejudice to the court cases mentioned above. The government also allocated gas to the power and fertilizer sectors on priority (there is no provision in the production sharing contract that enables the government to do so).

In October, the government impleaded itself as a party in the dispute between RIL and RNRL, and filed an affidavit which said in effect that its decision on allocation and price would be binding and that all other agreements would have no validity. On Friday, it clarified that $4.20 would be the actual price for the gas and not the floor price for valuation purposes, and that it was allocating gas to the Ratnagiri power plant on a priority basis.

Some important points arise. The first is that the government, through an executive decision, has unilaterally amended the terms of a contract entered into between it and the successful bidders five years after the contract was signed. It has done this while there are active disputes in the courts. Second, it has given up the gains of higher fuel prices—its profit share goes up with the price of gas—and capping it at $4.20, as was done on Friday, it has agreed to lower returns for the entire period of the project—a loss of thousands of crores, several times more than what it lost in the telecom spectrum allocation. Third, it has demonstrated the willingness and the ability to change allocations at will—the introduction of Ratnagiri as a priority happened last week, one year after the decisions for allocation of gas. It is easy to imagine the disruptions such decisions can cause in projects that had been earlier promised the gas supply. Fourth, it has unilaterally intervened in a court dispute, taking a particular position rather than allowing the contractual positions to be defended.

Overseas investors have always complained about the abysmal levels of enforcement of commercial contracts in India. This case is an example that the government is willing to interpret contracts differently at different times. If it looks at contractual arrangements as mere contextual ones, to be changed at will, it is little wonder that foreign investors have little faith in the rule of law in India.

S. Narayan is a former finance secretary and economic adviser to the prime minister. Your comments are welcome at policytrack@livemint.com